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FRM See A Strong CTA Bounce Back As Unlikley In Monthly View

onOctober 3, 2013

From FRM Investment Management

The HFRX Global Hedge Fund Index was positive in September, +0.96%, the majority of strategies ending the month with positive returns. Equity Long-Short managers were amongst the best performing strategies, benefitting from the equity market rally across regions in the first half of the month. Given the large moves seen in the emerging market assets, it is unsurprising to see that those hedge funds with a bearish tilt here were the underperformers.

Amongst Equity Long-Short managers, long biased managers were the outperformers on the month, capturing the strong up trend in the first half of the month. With the Nikkei posting its second strongest monthly performance (in a year of strong performance) it was unsurprising to see that Japanese focussed equity managers were the best performers on a regional basis. Market Neutral managers struggled in comparison to those with explicit directional calls, though considering the substantial macroeconomic news flow in September it wouldn’t be surprising to see stock dispersion drop off marginally. We would expect this dispersion to reappear shortly provided the macro risks in the US are avoided as we enter earnings season. In general we believe that the environment will continue to support stock picking over the next few months, though the returns attributable to beta may be reduced.

Credit Long-Short managers also generated positive returns in September. The credit market in general was up following the continued stimulus from the US government, though it appears that managers were doing well up to this point, with little profit or loss generated after the announcement. In a similar way to equity managers, it may be that the announcement and subsequent spread tightening resulted in a short term lull in dispersion. It is interesting to note that credit managers became less risk averse over September, with gross exposures increasing. This in part reflects the more stable outlook for rates markets in general. Our outlook for Credit Long- Short managers is positive. There is notable dispersion both within and between the various sections of the credit markets; HY and IG vs EM and municipal bonds; divergence of flows between fixed and floating rate product. Our long standing view of Credit Value managers remains, with the risk reward less attractive the greater the extension down the liquidity curve and the further through the credit cycle we move.

Event Driven managers had a strong September; the HFRX Event Driven Index was up 2% over the month. This figure is skewed somewhat by the special situations trades which contributed the majority of the returns; the HFRX Merger Arbitrage Index up just 41bps. This year has been characterised by a steady stream of returns from Event Driven managers, though very few months have stood out as exceptional; September was a continuation of this. Several popular deals completed (both the D.E master Blenders and Smithfields deals completed over the month) as well as a notable recovery in the spread of the AMR-US Airlines deal, a popular spread for special situations traders. The overall volume of announced deals was very high in September (290bn USD) however this figure was dramatically increased by the Vodafone-Verizon deal announcement (130bn USD); excluding this bumper deal, the volumes were in line with recent months. There have been several pieces of Investment Bank research, as well as conversations with managers that have indicated that the deal pipeline may be somewhat sparse in the fourth quarter. However, this is an area which is notoriously difficult to predict with any accuracy. We feel that until we see a sustained and notable uptick in activity it is unlikely that performance will improve dramatically.

Managed Futures performance was largely a function of the level of equity exposure that managers had to equities coming into the month; net longs are towards the highs of the year for a number of managers. As a result the performance figures were disperse over the month, though in aggregate they were positive. The interest rate exposure continues to be low in comparison to historic levels, though those managers who still have a marginal long exposure benefitted from falling yields over the month. Currency trading continues to be a challenge. The environment for Managed Futures has marginally improved over the last two months. With the expectation that front end rates stay anchored and the steeper yield curve remains, returns from carry and roll down should start to contribute to returns. Additionally portfolio construction has been helped as the correlation between the instruments that these managers trade has been steadily decreasing over 2013. That said we feel that a strong bounce back in performance is unlikely in the short term.

As usual for the last month in any quarter, price action in agricultural markets was dominated by the USDA grains report, released at the end of the month. The bearish positions managers had worked well. It is likely that as we exit the Northern Hemisphere crop cycle, price action will become more subdued. It is therefore unlikely that we will see any significant performance, either positive or negative, from these managers for some time. Natural gas traders again had a tough month, especially those managers attempting to trade from the long side. Currently injection numbers, the amount going into storage, and US weather are working against each other, making fundamental analysis difficult.

Returns for Emerging Market managers were determined by their positioning, with a large bounce back from previous months resulting in EM bears having significant losses. While the non-tapering has given some respite to those countries with balance of payments problems, the fundamental issues remain. It is likely that the difficult trading conditions may remain for some time.The HFRX Global Hedge Fund Index was positive in September, +0.96%, the majority of strategies ending the month with positive returns. Equity Long-Short managers were amongst the best performing strategies, benefitting from the equity market rally across regions in the first half of the month. Given the large moves seen in the emerging market assets, it is unsurprising to see that those hedge funds with a bearish tilt here were the underperformers.